All Heck Breaks Loose After Freaked-Out People’s Bank of China Devalues Yuan Again

How freaked out can the People’s Bank of China be about the Chinese economy that has been growing admirably at 7% this year, according to the government?

OK, there are some quibblers who might point out that car sales in July have plunged 6.6% to a 17-month low, after having already shrunk in June, and after having trended down all year, in the largest auto market in the world with the largest auto manufacturing capacity in the world that had been growing in leaps and bounds and had pushed job creation, investment, and GDP to new heights.

US automakers have bet the farm on China. This is where growth would come from. But in July, Ford sales through its joint ventures dropped 6% year-over-year, the third monthly decline in a row, and GM’s sales through its joint ventures dropped 4%. A vicious price war has broken out. In a market that has gotten used to seeing double-digit growth!

And granted, exports and imports plunged too, and producer prices plunged, and the totally crucial property sector is wobbly, and manufacturing plants get shut down as overcapacity is running rampant, and all kinds of other things plunged or stagnated or wobbled, and now the PBOC is truly freaking out.

Tuesday morning it had devalued the yuan by lowering the daily reference rate by a record 1.9% against the dollar. The spokesman called it a “one-time correction.”

The yuan – after moving no more than 0.01% against the dollar in the prior weeks and trading in Shanghai between 6.2096 and 6.2097 against the dollar for days – instantly plunged, and ended the day at 6.3248.

It shook up the markets, pushed down metals, oil, other commodities, and emerging market currencies. The Nikkei plunged until the Bank of Japan’s muscled intervention put a floor under it. As part of its well-communicated QQE policies, the BOJ buys equity ETFs when stocks start dropping. Hedge funds expect it and start buying with the BOJ. It works like a charm. And then in the US, stocks swooned too.

That was Tuesday. It was a “one-time correction,” as the PBOC said, so the markets would adjust and get over it and move on to the next topic. Surely they’d find something to be enthusiastic about.

That theory fell apart Wednesday morning in China, just as everyone was getting ready to settle in, when the PBOC devalued the yuan again, this time by 1.6%, the second biggest cut in two decades after yesterday’s record. As I’m writing this, the yuan is down to 6.437 against the dollar in Shanghai trading.

That’s a 3.4% devaluation in two days!

In offshore yuan trading, mayhem broke out: On Tuesday, the yuan plunged 2.8%, and on Wednesday morning, it dropped another 2.2%. That’s 5% in just two days!

A real devaluation. A broadside in the currency war. And given yesterday’s willfully false promise that it would be a “one-time correction,” more devaluations are now likely, regardless of what the PBOC might say, and in particular if it denies it.

Clearly, the Chinese government has decided to solve China’s economic problems via its currency. To heck with the rest of the world. This is exactly what the Fed, the Bank of England, the BOJ, and the ECB have done. Now it’s the PBOC’s turn.

And markets are having conniptions. Copper just dropped 1.8% in one breath to a new multiyear low of $2.294 per pound. Oil, which was up in the hours ahead of the announcement, dropped too, with WTI plunging nearly $1 after the announcement to a multi-year low of $42.89 a barrel.

The Nikkei plunged over 402 points as I’m writing this, or over 2%, to 20,319. Even the BOJ’s frantic buying has trouble stopping the cascade. Chinese stocks are under iron-fisted government control, and there isn’t much movement. But Hong Kong’s Hang Seng is down 500 points so far, or 2%. Singapore is down 2.6%.

These devaluations, the past two and the future ones, raise all kinds of questions and concerns: Would Apple products suddenly face even stiffer price competition in China, either cutting into its profits or its sales or both? We don’t have a crystal ball either, but we suspect what the answer might be. American tech products are going to have an even rougher time in China.

And what about the Chinese with money? What will they do? Sit there and watch their wealth get frittered away by PBOC’s currency war, like the Japanese and the Europeans are watching their wealth get frittered away? Unlikely. There may well be a tsunami of money from China into housing and other assets in trophy cities in the US, Canada, Australia, New Zealand, and other countries to further inflate, at least while the party lasts, the already breath-taking local housing bubbles.

But in its infinite wisdom, the PBOC already anticipated that; yesterday its spokesman said the PBOC and the State Administration of Foreign Exchange (SAFE) would examine the banks’ FX transactions, “adopt effective measures to fight money laundering, terrorist financing and tax evasion activities, and improve the monitoring of suspicious cross-border capital flow.” And they would “severely punish illegal FX transactions.”

Enjoy reading WOLF STREET and want to support it? Using ad blockers – I totally get why – but want to support the site? You can donate “beer money.” I appreciate it immensely. Click on the beer mug to find out how:

Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.

The PBOC move to devalue its currency is laughable (unless they decide to devalue gradually by 1.5% on each working day).
They say weak exports have contributed to the devaluation, along with the IMF telling the Chinese to make the Yuan more flexible.
IMO, Chinese export data is reporting fancy numbers for six years!!
70% of its export markets have barely recovered from their previous peaks in 2008, but china managed to increase its exports to the rest of the world by 64% from 2008 ($2.34T vs. $1.43T).
The U.S. numbers showed they import $466bn of Chinese goods in 2014, up from $337bn in 2008, up by 38%.
European imports are still below its 2008’s peak, along with Japan.
Other EM markets saw its currencies weakened against the USD (meaning it has weakened again the Yuan, till yesterday).
So where the Chinese are exports going to?
If China over-stated its exports, therefore it has over-stated its current account surplus, add in growing capital outflows, then things don’t look rosy in China.

Dan Romig

Aug 12, 2015 at 6:52 am

“And what about the Chinese with money? What will they do?” I would bet that they’ll acquire and hold gold. Fiat currencies are not what they appear to be-despite what Paul Krugman preaches in the New York Times.

illumined

Aug 12, 2015 at 8:58 am

I can’t help but wonder if the fuse is lit. I don’t expect US equities to tank quite yet, not with the acceleration of capital flight coming in, but it’s surely a sign that the end of the boom isn’t too far away.

MC

Aug 12, 2015 at 10:04 am

There’s one thing that I keep on wondering.

We now have three big export-driven economies locked in all out currency war: Japan, Germany and China. To these there must be added other two export driven countries, Switzerland and Sweden, though due to sheer monetary weight their central canks’ efforts have barely been enough to keep both the franc and the krona from appreciating too much against the euro.

It’s beyond doubt all the Big Three are aiming their efforts at increasing exports to the US: Toyota, BMW, Hitachi, Bosch etc are making a killing when US dollars are converted into their rapidly depreciating currencies.

Which leads me directly to my first point.

Can the US really take in steadily increasing volumes of imports? It seems to me the US economy is hardly steaming ahead. Even official (and hence embellished/massaged) data hardly paint a picture of prosperity. At best the US are dead in the water, at worst mired in a never ending depression.

Cheaper goods may prop up consumer spending by that tiny bit and goose GDP figures in the last quarter (Black Friday and Christmas shopping binges) but they are hardly a panacea, especially in areas hit by fracking/coal layoffs which are bound to continue for months at very least.

My second point is a bit more labyrinthine. I expect at very least one of these Big Three to drop dead in the next few years: currency wars never last long (see Switzerland and the BNS euro-peg) and always end in tears.

Most people are betting on Japan, but I take a contrarian view and say Germany.

The first problem is China. German groups are extremely exposed there, especially when it comes to profits. Many large export-oriented firms get over 20% of their profits from that single market, which is getting more and more shaky by the day and where imports have suddenly got a whole lot more expensive.
The second problem is Japan. As insane as the ECB is, it’s a pillar of monetary conservativism compared to the BOJ. Japanese goods in Europe have got really cheap and are chewing into what Germans traditionally considered captive markets. To make matters worse, Japanese goods don’t carry the same stigma as Chinese ones and are often the same quality and better engineered than their German counterparts. Sure, the euro can be devalued a bit more to make imports more expensive, but given how important Europe is as an export market for Japan Incorporated, the BOJ will surely reply in kind.

The third is Europe’s own internal situation. For all the never ending optimism displayed by Italian and Spanish leaders, the economic situation of so called Club Med countries is getting worse not by the day but by the minute. This will affect Germany in two ways: first, Greek-style bailouts will become both more common and more expensive. Keep an eye on that recovery miracle, Portugal, for the next round.

Bullying bankrupt, marginal Greece is one thing, bullying heavyweight Italy (a prime market for German exports) is quite another. Second, exports to France, Italy and Spain are not as good as they once were and have become too consumer-heavy. To cut a long story short, Club Med countries have started leveraging again to buy German cars and home appliances. Given leveraging ratios (especially in France), contracting wages and unemployment figures, this won’t last and won’t end well no matter what the ECB, Santander and Credit Agricole do.

nick kelly

Aug 13, 2015 at 6:57 pm

Germany is the last one I’d bet against- it is fundamentally healthier than the US.
The society is far less financialized- it isn’t swarming with MBA’s ( Germany like Japan traditionally had no schools of business- the field didn’t exist) or lawyers trying to shake down business every time someone falls of a ladder.
It has a healthier balance between labor and business- any company with more than (if I recall correctly) 100 employees has to have a union member on the board.
The degree of political animosity in the US is perhaps unique in the Western world, with maybe Britain a runner up.
The education system is far superior- half the high school grads go into apprenticeships- and are not thought of as diminished for doing so.
Oh, and there isn’t a massacre every few days or a bunch of lunatic fringe nut bars who are ‘sovereign citizens’
BTW- when you assess the level of German exports you will not of course look in Walmart. But it goes far beyond the obvious ones- Benz. BMW. Volkswagen, ( just took #1 spot from Toyo) Audi. Porsche,.
Those are consumer items- beyond that is the supp;y of all kinds machinery to business, ship building etc. etc. that is opaque to the average citizen.
Germany in dollar terms has been the world’s number one exporter for several of the last few years.

Angela Merkel lives in an ordinary apartment

Nick Kelly

Aug 13, 2015 at 7:41 pm

A ps: there is no where near the disparity between the salary of the CEO and the worker. In his book ‘Boomerang” about the financial crisis. Micheal Lewis tells us that when Goldman etc. realized their “AAA’ mortgage bonds were going to blow up they unloaded a bunch on gullible German bankers, who didn’t realize that Goldie might, like, ‘fib’
One German CEO almost went to jail, lost his job, and had to repay one year’s salary of EIGHT HUNDRED THOUSAND DOLLARS.
Sorry for the caps- in the book it’s in italics.
By US standards this sum is laughably small for the head of a major bank.

JacktheElectrician

Aug 12, 2015 at 10:28 am

Yuan is going to 7:1 by end of this year, and then to 10:1 over 2016.

Nick Kelly

Aug 12, 2015 at 12:19 pm

So let’s reflect- was this devaluation an unknown unknown or something that could have been anticipated or at least suspected?

Although hind sight is 20-20 our foresight looks pretty bad.
Facts: we have a state, an economy and one of the last ‘Communist’ parties left in their worst crisis since they discovered capitalism, stock markets etc. Serious people have suggested this could lead to social unrest- the most feared outcome for the CCP.

Despite efforts to enlarge the domestic part of the economy it remains hugely dependent on exports. Internal tinkering with the stock market does nothing major for exports.

So given that this state really only has one sword to brandish- why did the move come as a shock when in an hour of peril it does so?

At the risk of over- analyzing or worse, paranoia- there may be another factor.
There has been quite a bit of crowing- ‘I told ya so’ etc. etc. in the Western media. Some of this has explicitly stated that there is nothing China can do.

Well, It looks like it can do something. BTW- the devaluation is hurting luxury brands from Gucci to BMW.

This may not be unwelcome to the CCP as part of a re-education/ crack down on corruption etc.

.

Petunia

Aug 12, 2015 at 1:29 pm

First they dump $180B in US treasuries, increasing their foreign reserves, now they devalue. Looks like they have some kind of plan.

The devaluations really don’t impact their domestic economy if production gets consumed at home. The foreign companies producing there get hurt, either on the selling side or the FX side. The Chinese may pick up more western manufacturers at bargain prices, and now they have the cash to do it too.

hoop

Aug 12, 2015 at 3:14 pm

I read last week, that 850 billion left china the 2nd quarter and only 350 came in, via their trade balance. Something like a half a trillion net left china. It means people/business are changing their Yuan’s for dollars it means less dollars are available in china for circulation. Supply and demand.

The stock market crashed. Maybe some people/business, who get out in time, have been changing, their hard earned Yuan’s in dollars and they bring them outside of china for security reasons. They might think, that the stock market crash have some further to run.

The PBOC delivers them the USD, by selling first their treasuries, which would force interest rates up in the USA. But the people/business who bring their dollars outside china invest them again in something, looking to the market it seems they might have chosen treasuries. Which would force the USA rates down again. From a treasury point of view this could be a complete neutral thing.

That in this process, they (PBOC), time their actions and try to orderly bring supply and demand for the currency pair usd/cyn back in line, is to be expected from the PBOC. This is the main reason we have central banks. That the timing is set to fuck some people, is also to be expected. We life in a world of ‘forced’ redistribution by centralized authorities.

Maybe, that for some traders/investors, the move came as a surprise and that they got off-guard and where force to change their trend following investment theme’s, is hardly to be blame on the PBOC. This, might have caused, a certain sell off in the commodity atmosphere. Which is also a bit expected because every Chinese lost 3.5 pct of their spending power in USD. So, 1.3 billion people got a haircut in spending power.

Shawn

Aug 12, 2015 at 4:49 pm

How depressing if you are trying to get into the housing market. San Francisco medium prices for a house is now 1.36 million. It is fricking crazy. LA and SF metro are the most expensive in the country, pumped up purely by fillpers, foreign money and investors. Now you are saying it is going to get worse before a correction? California is a 7 year boom to bust (trough to peak) housing market, could this madness go on beyond 2017?

Thomas

Aug 13, 2015 at 9:03 am

We devalued our currency by about 94% since the federal reserve was given the keys to the hen house. “All heck” hasn’t broken out here. . . . . Yet